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First Quarter 2017 International Perspective

Quarterly Market Review

International equity markets turned in very strong performance during the first quarter of 2017, and although developed equities delivered strong returns, emerging markets (EM) were the notable outperformers. EMs generated an over 11% return—nearly double that of developed markets—in what was a very strong start to the year. EM equities were buoyed by views that the potential for protectionist trade measures may be more difficult for the U.S. to enact than previously thought, stretched valuations across much of the developed world which forced a tilt toward the relatively cheaper EM equity space, and strengthening local currencies relative to the U.S. dollar—a result of a more dovish tone than expected from the Fed.

Markets in Asia performed particularly well amid the recent impeachment and arrest of South Korea’s president following a long-running scandal and generally upbeat economic data (e.g., rising export/trade volumes driven by external strengthening demand).

In what should be seen as a strong positive for China as well as broader global economic growth, Chinese export and import growth has clearly based and begun to move higher, an indication that economic activity and trade is picking up around the world.

Following the brutal selloff in fixed income during the fourth quarter of 2016 (global bonds were down nearly 7%), global fixed income markets returned 1.55% through the first three months of the new year (as measured by the Bank of America Merrill Lynch Global Broad Market Index). The overall tone in bond markets was risk-on, with high yield and EM debt leading the way as investors continued to reach for yield. Perhaps as the Fed continues down its path of policy normalization, investors’ desire to move out on the risk spectrum in search of yield may gradually fade.

Manning & Napier Market Insights

Opportunities in Spanish Banks

The Spanish economy has been recovering from an acute double-dip recession that followed the bursting of Spain’s property bubble in 2008. While the recession was severe, GDP growth—at 3% YoY—is now among the strongest in the EU.

Spain has seen remarkable gains in productivity resulting from a 2012 overhaul of the labor market and the restructuring of the banking system. Consumer health continues to improve, and although unemployment is structurally high, a declining jobless rate and fairly healthy wage gains have pushed consumer confidence well above its long-term average. The health of the business sector has improved as well, with capacity utilization steadily increasing and strong growth in capital goods imports. Indeed, Standard & Poor’s raised its outlook on Spain’s sovereign credit rating to “positive” from “stable” on March 31.

We believe Spain’s improving economy provides a solid backdrop for its domestic banking industry. The sector was hit particularly hard amid the downturn due to its heavy exposure to the real estate market, which hurt asset quality, earnings, and capital ratios. Asset quality and earnings are improving, but there remains substantial room for further improvement, and generally speaking, Spanish banks are now adequately capitalized and in a position to increase loans after years of economy-wide deleveraging. These dynamics have led to our interest in select Spanish banks under our Hurdle Rate strategy.

In general, companies that fit our Hurdle Rate strategy are typically operating in weak or depressed industries where the longer-term outlook is expected to improve. Often, this strategy identifies cyclical industries with low demand, and as a result, shrinking capacity. The Hurdle Rate strategy attempts to find industry leaders who are positioned to benefit when industry conditions recover.

On the supply side, deteriorating net interest margins and poor returns below the cost of capital since the global financial crisis have led to capacity exiting Spain’s banking industry. The number of Spanish banks has steadily declined due to consolidation and bank closures, with a commensurate reduction in the number of bank employees.

On the demand side, Spanish businesses and consumers have significantly deleveraged since 2009, and the deleveraging process is nearing an end. Although loan growth remains negative, it has continued to improve for both businesses and households since the lows of 2013, and we are seeing growth in some areas such as consumer durable loans.

Along with positive GDP growth, we expect loan growth to continue recovering and anticipate that it could turn positive as early as the end of 2017. Positive loan growth will result in higher net interest income for Spanish banks levered to the domestic economy. The number of new non-performing assets should also decrease as the Spanish economy strengthens, and banks will need to provision less for loan losses. Lower provisions create an earnings tailwind, which should benefit Spanish banks over the next few years as well.

Regarding valuation, we view Spanish banks as attractive on a price-to-book basis, with many trading below book value. On a price-to-earnings basis, they appear more expensive. However, we believe price-to-book is a more useful measure for Spanish bank valuation due to currently depressed earnings.

Opportunities in Copper

We recently added exposure to a select number of international copper producers under our Hurdle Rate strategy. The copper industry has experienced several years of pain since prices sharply declined following the China driven commodity supercycle, as evidenced by collapsing returns and profitability in the industry.

This pain along with balance sheet strain for many miners has stymied copper project investment, leading to a decline in capex for expansion since its peak in 2012. We forecast slowing of supply growth for the next few years given that it takes at least 3 to 5 years to bring on new copper production after initial construction of a copper project. Furthermore, the combination of copper scarcity and declining ore grades makes it increasingly expensive to deliver each incremental unit, presenting secular challenges to copper supply.

On the demand side, support for copper is a function of global GDP growth. Our estimates are in line with average historical growth rates, and we expect demand to remain resilient. We forecast structurally lower growth to persist at similar levels in China, whereas growth in developed markets will remain slow. EMs in Asia and Latin America, however, may accelerate, as growth in many of these countries has likely bottomed. Based on our overall supply and demand outlook, we believe there is a large multi-year deficit developing that may drive a copper price rebound as the market moves into balance.

Copper also typically does well amid higher U.S. rates, since copper prices often benefit from improving growth. Therefore, we view the current U.S. backdrop as further supporting our outlook for copper.

The MSCI ACWI Index (ACWI) is a free float-adjusted market capitalization index that is designed to measure global developed and emerging market equity performance and consists of 46 developed and emerging market country indices. The Index returns do not reflect any fees or expenses. The Index is denominated in U.S. dollars. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation.

The MSCI World Index excluding the U.S. (MSCI WorldxUS) is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance and consists of 22 developed market country indices. The Index returns do not reflect any fees or expenses. The Index is denominated in U.S. dollars. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets and consists of 23 emerging market country indices outside the U.S. The Index returns do not reflect any fees or expenses. The Index is denominated in U.S. dollars. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation.

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance and consists of 23 developed market country indices. The Index returns do not reflect any fees or expenses. The Index is denominated in U.S. dollars. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation.

The Bank of America (BofA) Merrill Lynch Global Broad Market Index is a capitalization-weighted index that tracks the performance of publicly issued debt in the major domestic and eurobond markets, including sovereign, quasi-government, corporate, securitized and collateralized securities. The Index is rebalanced on the last calendar day of each month and only includes investment-grade securities with maturities of at least one year and a fixed coupon schedule. Index returns do not reflect any fees or expenses.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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